What is a Jumbo Loan?

Jumbo Loan

On the surface, the explanation of what constitutes a jumbo loan compared with a conventional loan should be pretty straightforward.

In fact, it is if you base it strictly on definition.

A jumbo loan applies to mortgage loans that exceed the limit – currently $417,000 for a one-unit property – to be backed by the government-sponsored loan guarantors Fannie Mae and Freddie Mac.

This seems simple, right? Well, yes and no.

In fact, there are caveats and exceptions to what constitutes a jumbo loan. There are also differences in mortgage loan rates for jumbo and conventional loans.

Finally, there is the question of why the distinction between jumbo and conventional loans is even necessary.

Let’s take a look at the question again and see if we can shed a little more light on the subject.

What is a jumbo loan?

In the United States, there are approximately 3,300 counties. Of those, around 100 of them have been designated as high-cost areas and have mortgage loan limits of $625,500.

A further 100 or so counties have loan limits that fall somewhere in between the $417,000 and $625,500 limits, based upon average home prices and median household income amounts.

A jumbo loan is any loan that falls outside of these conforming limits.

“Jumbo loans have historically

come with higher interest rates.”

Keep in mind, we’re talking about limits to what is considered a conforming loan.

A mortgage lender can lend any amount he or she wishes to a home buyer. If this happened, then they would not be able to sell the loan to Fannie and Freddie.

The reason jumbo loans have typically come with higher interest rates is because the lenders have seen them as higher risk loans. The higher the loan amount, the more of the bank’s capital is at risk.

Also, it is harder to sell the high-priced homes in the case of a default. The problem with that reasoning is the loan default numbers don’t support it.

This brings us to the final question.

Why are there different loan rates?

Default rates for higher priced homes during normal economic conditions are actually lower than the average default rate for homes that fall within the conventional loan amounts.

They are not riskier in that sense. However, if a lender gives out a jumbo mortgage, they must keep that loan on their books because, as a nonconforming loan, Fannie and Freddie can’t touch it.

They lose the ability to free up capital and make more loans and there is the risk to the lender.

A jumbo loan will always be a jumbo loan, at least while Fannie Mae and Freddie Mac are still around.

Banks will always charge a slightly higher rate (and with more restrictions) for this type of loan.

Photo source: www.catalystlending.com

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